Kraft General Foods, Inc v. Iowa Department of Revenue and Finance
| Citation | 505 U.S. 71,112 S.Ct. 2365,120 L.Ed.2d 59 |
| Decision Date | 18 June 1992 |
| Docket Number | No. 90-1918,90-1918 |
| Parties | KRAFT GENERAL FOODS, INC., Petitioner v. IOWA DEPARTMENT OF REVENUE AND FINANCE |
| Court | United States Supreme Court |
The Iowa statute that imposes a business tax on corporations uses the federal tax code's definition of "net income" with certain adjustments. Like the federal scheme, Iowa allows corporations to take a deduction for dividends received from domestic, but not foreign, subsidiaries. However, unlike the federal scheme, Iowa does not allow a credit for taxes paid to foreign countries. Petitioner Kraft General Foods, Inc., a unitary business with operations in the United States and several foreign countries, deducted its foreign subsidiary dividends from its taxable income on its 1981 Iowa return, notwithstanding the contrary provisions of Iowa law. Respondent Iowa Department of Revenue and Finance (Iowa) assessed a deficiency, which Kraft challenged in administrative proceedings and subsequently in Iowa courts. The Iowa Supreme Court rejected Kraft's argument that the disparate treatment of domestic and foreign subsidiary dividends violated the Commerce Clause of the Federal Constitution, holding that Kraft failed to demonstrate that the taxing scheme gave Iowa businesses a commercial advantage over foreign commerce.
Held: The Iowa statute facially discriminates against foreign commerce in violation of the Foreign Commerce Clause. It is indisputable that the statute treats dividends received from foreign subsidiaries less favorably than those received from domestic subsidiaries by including the former, but not the latter, in taxable income. None of the several arguments made by Iowa and its amici—that, since a corporation's domicile does not necessarily establish that it is engaged in either foreign or domestic commerce, the disparate treatment is not discrimination based on the business activity's location or nature; that a taxpayer can avoid the discrimination by changing a subsidiary's domicile from a foreign to a domestic location; that the statute does not treat Iowa subsidiaries more favorably than those located elsewhere; that the benefit to domestic subsidiaries might be offset by the taxes imposed on them by other States and the Federal Government; and that the statute is intended to promote administrative convenience rather than economic protectionism justifies Iowa's differential treatment of foreign commerce. Pp. 75-82.
465 N.W.2d 664 (Iowa 1991), reversed and remanded.
Jerome B. Libin, Washington, D.C., for petitioner.
Marcia Mason, Des Moines, Iowa, for respondent.
Kent L. Jones, Washington, D.C., for U.S. as amicus curiae by special leave of Court.
In 1981 petitioner Kraft General Foods, Inc. (Kraft) operated a unitary business throughout the United States and in several foreign countries. Because part of its business was conducted in Iowa, Kraft was subject to the Iowa Business Tax on Corporations.1 At issue in this case is Iowa's inclusion in the tax base of the dividends that Kraft received from six subsidiaries, each of which was incorporated and conducted its business in a foreign country.2 While Iowa taxes the dividends that a corporation receives from its foreign subsidiaries, Iowa does not tax dividends received from domestic subsidiaries. The question presented is whether the disparate treatment of dividends from foreign and from domestic subsidiaries violates the Foreign Commerce Clause.3
The Iowa statute uses the federal definition of "net income" with certain adjustments.4 For federal tax purposes, corporations are generally allowed a deduction for dividends received from domestic subsidiaries.5 As the earnings of the domestic subsidiaries, themselves, are subject to federal taxation, this deduction avoids a second federal tax on those earnings.6 The Federal Government generally does not tax the earnings of foreign subsidiaries, and the dividends paid by foreign subsidiaries are not deductible. The parent corporation, however, does receive a credit for the foreign taxes paid on the dividends and on the underlying foreign earnings.7 Like the deduction for domestic subsidiary dividends, the foreign tax credit is intended to mitigate multiple taxation of corporate earnings.8
In following the federal scheme for the calculation of taxable income, Iowa allows a deduction for dividends received from domestic subsidiaries, but not for those received from foreign subsidiaries. Iowa does not directly tax the income of a subsidiary unless the subsidiary, itself, does business in Iowa.9 Thus, if a domestic subsidiary transacts business in Iowa, its income is taxed, but if it does not do business in Iowa, neither its income nor the dividends paid to its parent are taxed. In the case of the foreign subsidiary doing business abroad, Iowa does not tax the corporate income, but does tax the dividends paid to the parent.10 Unlike the Federal Government, Iowa does not allow a credit for taxes paid to foreign countries. See 465 N.W.2d 664, 665 (Iowa 1991).11
In computing its taxable income on its 1981 Iowa return, Kraft deducted foreign subsidiary dividends, notwithstanding contrary provisions of Iowa law.12 Respondent Iowa Department of Revenue and Finance (Iowa) assessed a defi- ciency. After its administrative protest was denied,13 Kraft challenged the assessment in Iowa courts, alleging that the disparate treatment of domestic and foreign subsidiary dividends violated the Commerce Clause and the Equal Protection Clause 14 of the Federal Constitution. The Iowa Supreme Court rejected the Commerce Clause claim because petitioner failed to demonstrate "that Iowa businesses receive a commercial advantage over foreign commerce due to Iowa's taxing scheme." Id., at 668. In considering Kraft's challenge under the Equal Protection Clause, the court found that Iowa's use of the federal formula for calculation of taxable income was convenient both for the taxpayer and for the State. Concluding that the Iowa statute was rationally related to the goal of administrative efficiency, the Iowa Supreme Court held that the statute did not violate equal protection. Id., at 669. We granted certiorari. 502 U.S. ----, 112 S.Ct. 931, 117 L.Ed.2d 103 (1992).
The principal dispute between the parties concerns whether, on its face, the Iowa statute discriminates against foreign commerce. It is indisputable that the Iowa statute treats dividends received from foreign subsidiaries less favorably than dividends received from domestic subsidiaries. Iowa includes the former, but not the latter, in the calculation of taxable income. While admitting that the two kinds of dividends are treated differently, Iowa and its amici advance several arguments in support of the proposition that this differential treatment does not constitute prohibited discrimination against foreign commerce.
Amicus United States notes that a subsidiary's place of incorporation does not necessarily correspond to the locus of its business operations. A domestic corporation might do business abroad, and its dividends might reflect earnings from its foreign activity. Conversely, a foreign corporation might do business in the United States, with its dividend payments reflecting domestic business operations. On this basis, the United States contends that the disparate treatment of dividends from foreign and domestic subsidiaries does not translate into discrimination based on the location or nature of business activity and is thus not prohibited by the Commerce Clause.
We recognize that the domicile of a corporation does not necessarily establish that it is engaged in either foreign or domestic commerce. In this case, however, it is stipulated that the foreign subsidiaries did, in fact, operate in foreign commerce and, further, that the decision to do business abroad through foreign subsidiaries is typically supported by legitimate business reasons.15 By its nature, a unitary business is characterized by a flow of value among its components. See Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, 178, 103 S.Ct. 2933, 2947, 77 L.Ed.2d 545 (1983). The flow of value between Kraft and its foreign subsidiaries clearly constitutes foreign commerce; this flow includes the foreign subsidiary dividends, which, as Iowa acknowledges, themselves constitute foreign commerce.16
Moreover, through the interplay of the federal and Iowa tax statutes, the applicability of the Iowa tax necessarily depends not only on the domicile of the subsidiary, but also on the location of the subsidiary's business activities. The Federal Government generally taxes the income that a foreign corporation earns in the United States.17 To avoid multiple taxation, the Government allows a deduction for foreign subsidiary dividends that reflect such domestic earnings.18 In adopting the federal pattern, Iowa also allows a deduction for dividends received from a foreign subsidiary if the dividends reflect business activity in the United States. Accordingly, while the dividends of all domestic subsidiaries are excluded from the Iowa tax base, the dividends of foreign subsidiaries are excluded only to the extent they reflect domestic earnings.19 In sum, the only subsidiary dividend payments taxed by Iowa are those reflecting the foreign business activity of foreign subsidiaries. We do not think that this discriminatory treatment can be justified on the ground that some of the (untaxed) dividend payments from domestic subsidiaries also reflect foreign earnings.
In a related argument, Iowa and amicus United States assert that Kraft could conduct its foreign business through domestic subsidiaries instead of foreign subsidiaries or,...
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